EU and ECB raise doubts over the level of public spending

Jean Claude
Trichet, president of the European Central Bank, and Joaquin Almunia, EU
commissioner for economic and monetary affairs, have expressed concern about
the ability of the Italian government to steer the country towards a balanced
budget by 2011. Speaking at a meeting of European finance ministers in Porto,
Trichet singled out Italy and France as the two countries which have to show a
particularly strong commitment to fiscal discipline in the coming years.
Almunia added that Italy must not relent in its efforts to reduce the level of
public debt which is the highest in the eurozone.

Trichet and
Almunia saw themselves compelled to express their worries about the fiscal
situation in Italy since earlier this year the government led by Romano Prodi
loosened its commitment to reduce the deficit. Under pressure from the radical
left, Prodi and his economy minister Tommaso Padoa Schioppa agreed to increase
spending on low pensions and families, thus raising the forecast of the deficit
from 2.3 to 2.5 per cent of GDP in 2007 and from 2 to 2.2 per cent in 2008. The
government intends to reduce the deficit to 1.5 per cent in 2009 and 0.7 per
cent in 2010, arriving at a balanced budget in 2011. However, many observers
regard these projections as overly optimistic. Given that Prodi and Padoa
Schioppa have already given in to the demands of the far-left this year, it is
difficult to foresee why they should be any more resistant in the future. The
vulnerability of the Prodi government to the demands of the radical left is due
to the coalition’s reliance on the communists’ votes in the Senate. The
willingness of the biggest communist party (PRC) to pressurize Prodi on the
budget was demonstrated again yesterday when the former head of the PRC and
current president of the Chamber of Deputies, Fausto Bertinotti, remarked that
the fiscal commitments of the European Stability and Growth Pact should not be
regarded as a dogma and that social spending is a higher priority.

European
observers are especially worried about the reliability of the Prodi government
on fiscal matters since Padoa Schioppa’s plan to achieve a balanced budget by
2011 already required a concession by the EU commission as most other eurozone
countries eliminate deficits in 2010 or in some cases even earlier. At the same
time, the Prodi government cannot complain about the revenue side of its
budget. Tax revenues between January and August are about 7 billion euros
higher than estimated in March; a development which should normally have
accelerated the reduction of the deficit and which demonstrates that the real
problems of public finance are still caused by a lack of control on spending.

Another
concern implicit in the warnings expressed by Trichet and Almunia has to do
with the uncertainties about future growth rates. The current government’s
projections on the budget depend on bright economic conditions. In the
meantime, however, Padoa Schioppa has had to admit that the growth prospect for
2007 needs to be downsized from 2 to 1.8 per cent and that similar revisions
may need to made for the next year. The latest statistics on manufacturing
output are disappointing and it is becoming apparent that the Italian economy
is currently over-dependent on domestic consumption with exports and
investments not fully recovering. With these doubts hanging over the economy,
it is difficult to see how the governing coalition will be able comply with the
fiscal commitments made to the other members of the eurozone.